The Rise and Fall of Money Manager Capitalism

Eric Tymoigne, L. Randall Wray

• Publisher: Routledge
• Year: 2013
• ISBN:
  9781135076726
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

The book studies the trends that led to the worst financial crisis since the Great Depression, as well as the unfolding of the crisis, in order to provide policy recommendations to improve financial stability. The book starts with changes in monetary policy and income distribution from the 1970s. These changes profoundly modified the foundations of economic growth in the US by destroying the commitment banking model and by decreasing the earning power of households whose consumption has been at the core of the growth process.

The main themes of the book are the changes in the financial structure and income distribution, the collapse of the Ponzi process in 2007, and actual and prospective policy responses. The objective is to show that Minsky's approach can be used to understand the making and unfolding of the crisis and to draw some policy implications to improve financial stability.

1 The Minskian framework

This chapter presents the theoretical framework that will be used in the entire book to analyze the causes, unraveling, and consequences of the Great Recession. Following the crash, the work of Hyman Minsky gained some attention among academics and the popular press. They have especially acknowledged the relevance of the Financial Instability Hypothesis (FIH) to explain what happened in the late 2000s. However, as one may expect, most of what has been retained from the FIH is a narrow, and rather simplistic, narrative based on bubble, greed, and irrationality that is best illustrated by Kindleberger’s Manias, Panics, and Crashes. If that was the only thing that Minsky had to offer, his contribution to economic theory would be marginal given that many authors have made those claims long before him. The point of this chapter is to provide a more detailed presentation of the Minskian framework from its hypotheses, to its logic, and, finally, to its policy implications. As shown in the rest of the book, this framework helps to build an understanding of what happened over the past fifty years rather than only what happened in the past five.

In the concluding chapter of the General Theory, Keynes noted that the “outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes” (1936: 372). Minsky took this conclusion to heart but also noted that

although the obvious flaw in capitalism centers around its inability to maintain a close approximation to full employment, its deeper flaw centers around the way the financial system affects the prices and demands of outputs and assets […] so that conditions conducive to financial crises are endogenously generated.

(1994b: 19)

As a consequence, Minsky aimed at providing policy solutions to deal with those issues in order to promote stable lasting full employment. In order to do so, he developed a theoretical framework that synthesizes the work of John Maynard Keynes, Joseph Schumpeter, and Irving Fisher. In a nutshell, the central message of the Minskian framework is that, over time, capitalist economies are intrinsic-ally financially unstable even if people are rational, even if the economy is regulated properly at a point in time, and are even more unstable if market mechanisms are left alone. Stated alternatively, the economic system, rather than the morality and intelligence of individuals or the state of market structures, is at the source of most of the economic problems we face today. Government intervention can help to limit the instability of the system but, over time, the effectiveness of a given set of policies tends to erode and the policy arrangements may even promote instability. Thus, in order for capitalist economies to promote durable prosperity, government intervention must be highly proactive and constantly keep up-to-date with what goes on in the rest of the economy.

The nature of capitalism

Minsky was highly influenced by Institutional Economics and believed that an economic theory must be rooted into the institutional structure of the economic system it tries to explain. He rejected the idea that an economic theory can apply to all economic systems past and present, and argued that a careful analysis of the existing socio-political-economic institutions is necessary to formulate a meaningful analysis of existing economic problems. As a consequence, Min-sky’s theoretical framework is not valid for all economic systems; it is a theory of capitalism built through a detailed observation of the capitalist financial system gained partly by sitting on the executive boards of banks. This led him to characterize capitalism in the following way: “A capitalist economy […] [is] an integrated production, trading, and wealth owning system, with a structure of financial claims and commitments, [that] operates through real world and irreversible time” (1983b: 106). The central goal is, therefore, to include these elements into a coherent theoretical framework. As shown below, this has serious implications in terms of the core concepts and of the methodology that will be used to do economics.

Real-exchange economy vs. monetary-production economy

Keynes noted that there are two points of departure when practicing economics: real-exchange economy (or cooperative economy) and monetary-production economy (or entrepreneur economy). Each point of departure has a specific understanding of what capitalism is and begins from specific concepts that it uses to analyze this economic system. As a consequence, each point of departure has a specific understanding of the main problems that are recurrent in capitalism and so a specific view of the means to use to deal with those problems.

Real-exchange economy

Most academics practice economics within a real-exchange economy which is at the core of Robins’ famous definition of economics: “Economics is the science which studies human behavior as a relationship between ends and scarce means which have alternative uses” (Robins 1945: 16). This framework of analysis starts with three central premises: resource scarcity, efficient market theory, and rational agents. It argues that the study of exchange in a barter economy with small independent producers is a good proxy to understand the basics of capitalism:

Despite the important role of enterprises and of money in our actual economy, and despite the numerous and complex problems they raise, the central characteristic of the market technique of achieving co-ordination is fully displayed in the simple exchange economy that contains neither enterprises nor money.

(Friedman 1962: 13)

Money can be added to the story but it does not substantially change anything. It merely smoothes exchange and is not sought for itself, and so does not influence allocation, production, and distribution. In this context, the central goal of economics is to study exchange mechanisms in order to find the most effective means to manage scarcity.

According to this framework, since human beings have existed they have had to deal with scarcity of resources. Scarcity means that limited resources are available to satisfy unlimited wants/preferences. In this context, the central goal of markets is to allocate scarce resources to the most efficient economic endeavors (i.e., the ones that produce the most output given inputs). In order to do so, prices must be able to move freely to eliminate shortages and surpluses, and market participants must strive to discover and undertake the most productive activities. Under strong market efficiency, these market adjustments are instantaneous and prices reflect all the relevant information (also called “fundamentals”) about whatever is traded—productivity, time preference, available resources (Fama 1970). As a consequence, there can never be any bubble (i.e., times when prices do not reflect fundamentals) or misallocations of resources and so financial crises are impossible.

For market mechanisms to work efficiently, several conditions must be met. A first condition concerns the market structure: perfect competition must apply. Perfect competition requires that five criteria be met: atomicity, transparency, homogeneity, free entry/exit, and perfect mobility. Atomicity means that no market participant has market power, i.e., no buyer or supplier has any bargaining power to set prices. Transparency means that all information that needs to be known about whatever is traded is known and costless to obtain. Neither buyers nor sellers have private information that can be hidden. Thus, when a borrower goes to a bank, the bank knows everything about the borrower’s project who cannot hide any negative information or embellish positive information. Homogeneity means that all the goods traded in a market and serving the same purpose are exactly the same. In financial markets, this means that all financial securities trade in organized exchanges. Free entry and exit means that market participants can come and go as they wish in the market, i.e., financial markets are perfectly liquid. Perfect mobility means that labor and capital can move freely anywhere in the world immediately and at no cost; there is no such thing as capital controls or market barriers.

Assuming that pure and perfect competition applies, a second condition for markets to work properly concerns the behaviors of individuals—they must properly account for market mechanisms. For example, financial-market participants must follow a long-term fundamental approach to asset pricing, i.e., they must ignore changes in monetary returns that are unrelated to “real” changes such as capital and labor productivities, and leisure and time preferences. This means that they must be able to select and acquire all relevant information and to compute it in order to make a decision; having highly powerful computers, and a good education help to make this a reality. Individuals must also be free of “biases” like monetary illusion, over-optimism, being influenced by the way the information is provided, and other traits that are not typical of homoeconomicus. Individuals take market information as an input immediately usable without interpretation, and do not care about what others think or how others behave. All this ensures that market participants use price signals to allocate resources to the most productive activities.

A third condition for markets to work properly is that government should not interfere with perfect markets. Price variations should not be influenced by government because this would violate atomicity; usury laws and minimum wage laws are bad policies that interfere with voluntary contracting. Similarly, the government should not provide any financial help to individuals who want to get an education, to acquire a house, or to start a small business. Doing so would violate atomicity again so prices would not reflect only available information about fundamentals. As a consequence, prices would provide wrong signal inputs to market participants who would then make inappropriate decisions, leading to an oversupply of goods in some markets and an undersupply in others.

Any deviation from this ideal state is called an “imperfection.” This imperfection can come from markets (price rigidity, asymmetry of information, or others), or from individuals (irrational, i.e., non-homoeconomicus, behaviors). Imperfections are sufficient, but not necessary, sources of market inefficiencies and so the point becomes to study potential sources of inefficiencies and to correct them (Fama 1970). The effects of imperfections may be compounded by perverse market incentives induced by market dynamics and externalities. These market failures lead to misallocations of resources and the closures of sound companies. Thus, in some cases, market discipline punishes market participants indiscriminately, promotes highly destructive debt-deflation processes (Fisher 1932, 1933), and undersupplies or oversupplies some economic activities. In these cases, there is a role for government regulation to compensate for market failures (Stiglitz 2010). This broad theoretical framework has been used by many different schools of thought to explain financial crises, from the Monetarists to the Behavioralists.

Monetary-production economy

Marx (1894), Veblen (1904), and Keynes (1933a, 1933b, 1933c, 1936) were three prominent authors who argued that capitalism is a monetary-production economy and Minsky followed their paths. The central aspect of this type of economy is that commodities need to be produced before they can be exchanged. Production is planned with the expectations of selling output, needs to be financed, takes time to be implemented and completed, gathers groups with different economic interests, and involves irreversible decisions. All this is done in the context of large-scale capital-intensive businesses evolving in a competitive environment that seeks monetary accumulation and imposes monetary return targets. Thus, capitalism cannot be approximated by a barter economy with money simply serving as a medium of exchange and with small independent producers.

The framework of analysis described in the previous section emphasizes the role of market exchange in the allocation of scarce resources while giving minimal attention to production. Those who adopt the monetary-production approach have three main problems with the real-exchange approach. First, they argue that scarcity is not natural but rather is institutionally created and rarely an issue—abundance should be the point of departure, not scarcity (Dugger and Peach 2008). Indeed, unlimited wants are not intrinsic characteristics of human beings but rather have been manufactured by capitalists in order to open new markets (Galbraith 1958, 1967).¹ Second, scarcity is rarely an issue because unemployment and excess production capacities are usual states of capitalism; instead, poverty (i.e., incapacity to satisfy limited basic needs) amid plenty is the core problem of developed capitalist economies. Third, beyond scarcity, the socio-economic aspects of production must be analyzed in detail because they are seen as crucial to explain the dynamics of capitalism. Indeed, production gathers two broad classes, workers and capitalists (with subdivisions in each), that have opposite core interests in the production process. This generates inter- and intra-class conflicts over methods of production and income distribution. As a consequence, income distribution is not based mainly on productive efforts but on relative powers.

In addition to studying production and distribution, one must understand how money affects the dynamics of capitalism. Money is not something that can be added as an afterthought to lubricate exchange. Business activities must be financed before they can be started and production is only undertaken if it is expected to be profitable in money terms. A business does not have to be productive, efficient, or useful, the only thing that matters is that money can be generated, which may entail a sabotage of production by capitalists in order to maintain artificial scarcity (Veblen 1921). Thus, the activities that generate the highest expected monetary returns, rather than the highest output, will be implemented, and capitalists may promote shirking and destroy capital if it is too productive. Businesses and households that do not comply with this rule and do not succeed in generating the expected return are ruthlessly eliminated, forcing workers and entrepreneurs to focus on monetary issues even if they have greater aspirations—high quality, durability, craftsmanship, great engineering, etc.—when starting an activity. Their socio-economic survival depends on submitting to the imperative to generate, not only a profit, but the profitability norms set by the competitive setup in their sector. This implies constant innovation and growth, and the result is that growth for the sake of growth (rather than for the sake of improving standards of living) becomes a central goa...